Show Me the Money
What's an administrator to do? State funding is down, student enrollment is up, economic diversification groups demand courses with limited enrollment that may lose money, and the Board wants the fund balance in the black at year-end.
We suggest that you determine the profitability of all your course offerings. Then you can determine the cost or profit of adding additional courses with specified enrollments. And yes, we've done it; this is not a theoretical treatise. And no, it won't take a high-priced consultant. Let's review a bit of cost volume profit (break-even) analysis. Then we will apply it to our universal college example. Finally, we will present some examples of the knowledge this provides and what to do with it.
Break-even or cost volume profit analysis requires a different way of looking at the revenue/income statement. (This topic is covered in most managerial accounting texts.) Instead of your traditional FASB-mandated system, one needs to think in terms of variable and fixed cost. In short:
<b>Revenue - Variable Costs = Contribution
Margin - Fixed Costs = Profit </b>
We will be considering the direct revenue and the direct variable costs associated with teaching courses. Direct revenue consists of:
<b>State Funding + Tuition Revenue + Lab Fees = Direct Revenue </b>
Direct expenses or variable costs consist of:
<b>Faculty Salaries + Adjunct Faculty Salaries + Other Salaries + Opt Exp = Direct Expense </b>
Our result is then:
<b>Direct Revenue - Direct Expense = Contribution Margin </b>
More importantly, contribution margin can be seen as course profit or loss.
Let's touch on the theory of what cost volume profit is all about. When net revenue exceeds variable expense plus fixed expense, the college makes money on the course. When revenue minus variable expense is a positive number, the course offering is making a positive contribution to covering all the rest of the fixed costs of the college. When revenues minus variable expense is a negative number, the course offering must be paid for by other courses; it is not covering fixed costs and must be supplemented elsewhere.
Variable costs in our example here are the only costs associated with teaching courses. The salaries of full-time and adjunct faculty plus direct out-of-pocket course costs, such as classroom fees or lab costs, are variable costs. All other costs are fixed. That's right--in our example, all administrators, staff, rent, utilities, bond interest, etc., are fixed expenses. Those fixed expenses are the ones you cannot do anything about. The variable expenses, however, are controlled by the total course offerings. We gathered our statistics in an Excel spreadsheet as shown in the chart on the next page.
The spreadsheet unfolds in a predictable manner. Enrollment data is analyzed with enrollment, student contact hours (SCH), total contact hours, the number of sections, and finally, by dividing the enrollment per section. Note that the courses do not appear to be in order by enrollment. They are not ... but more on that in a moment. Next, direct revenue is computed as shown. Then the variable costs of faculty plus other salaries plus operating expense plus capital outlay total the direct expense. Note that capital outlay for that particular course offering becomes a variable expense. If that course were not offered, we would not be expending those funds. Hence, an expenditure whose benefit extends beyond one year is still seen as a variable expense in this example. Then we simply subtract total expense from total revenue. Now, what is the logic of the ranking?
profitable on a unit basis
to teach history than math.
We have ranked the courses in order of each overall contribution margin. Why? Because we want to know the total contribution margin or total profit/loss of that course. In our example, it is actually more profitable on a unit basis to teach history than math. History has the highest contribution margin percentage (64.1). But the largest overall contribution is from math. Math's total contribution exceeds history's by over a half a million dollars.
The importance of overall contribution margin as the ranking factor becomes obvious as one scans down the chart. Eventually we come to the course that contributes the least to overall fixed cost; in this case, it is poetry writing. Note that it has a low contribution margin of only 4.7 percent, but it still makes a positive contribution towards fixed cost. Next on the list is our first loser, so to speak. Dance is losing $1,938 and has a negative contribution margin of 2 percent. We then scan down to our No. 1 loser, nursing, at a whopping -$528,927. Indeed, its contribution margin percentage at -60 percent is right between the positive margin of our winners--math and history.
So we add more of what makes the most money and ax the losers, right? Not at all. This analysis shows exactly what each course makes or costs. There are many reasons a college might want to offer courses that are not making a fixed-cost contribution. The school may be starting a new program or responding to a particular community interest. The information on course loss could be used in a different manner. The amount in the negative also indicates what it would take for a course to break even. In the case of a nursing course, a local hospital might offer to make up the difference to supply its personnel needs. Additional uses for this information might include the following:
It is immediately apparent that large segments are served at an attractively low cost. The total expense can be divided by the enrollment to calculate a cost per student for every course offered. Such information can be particularly useful at the legislature to show your college offers the same service as others but at a lower unit cost. Hence, you deserve more funding.
The contribution margin column total indicates whether the budget is in balance--and why or why not. If this total is more than the remaining cost of running the college, the budget must have a surplus. If it is not, one knows which courses contribute the most and the least.
This is an aid in opportunity-based costing--if there is only money to hire one category of professor, one now knows which area will help the bottom line the most.
This becomes a tool to show departments in the red exactly what it takes to break even. Whether it is more enrollment or fundraising or more economical teaching methods, this offers a clear picture of why costly courses are, well, costly.
It forces department heads to think in terms of activity-based costing as opposed to traditional costing systems. Now the business office can help in breaking down their costs along activity lines--after all, we are not producing widgets here.
It gives administrators hard, cold facts about what expensive (nursing) or lightly enrolled (dance) classes cost. If the community wants such courses, this analysis may support higher tuition or lab fees to afford them.
This analysis could conceivably help the development effort. High-cost courses such as physics seminars at the Ph.D. level demonstrate to donors why their help is needed.
Our purpose is to provide a new way of looking at the financial contribution of course offerings. The information can be gathered with relative ease in the ever-popular Excel spreadsheet. The information is useful at both the macro level of overall budgeting--what contributes or does not contribute to being in the black? It is also helpful at the micro level of opportunity costs, giving department heads a better idea of how their operation stacks up against other offerings. We believe this will be a valuable tool in the continuing call for accountability and outcome measures for colleges.
Dennis Elam (De10@riverrats.net) is an assistant professor of Accounting at Texas A&M University Kingsville/San Antonio campus; Ben Ferrell (firstname.lastname@example.org) is vice president for Business Services for the Austin Community College District (Texas).